Weekly Radar: In the shadow of the cliff

It’s been another rum old week market-wise, with global stocks off another 2 percent or more and recording seven straight days in the red for the first time since August. Throw any spin you like at the reasoning, but the pretty predictable post-election hiatus on U.S. fiscal cliff worries now seem to be front and centre of everything. And that will just has to play itself out now, leaving markets stuck in this funk until they come up with the fix. The running consensus still seems to be that some solution will be reached, but no one wants to be too brave about it. And given the cliff is one of the few good explanations for the sharp divergence between the equity market and still rising US economic surprises, you can see why many feel the US fiscal standoff is merely delaying a resumption of the rally.

The euro zone story has rumbled again of course, with the Greek hand-to-mouth financing, pressure for official sector debt write-offs there and another nervy wait for the latest tranche of bailout funds. Anti-austerity protests in Greece, Spain, Portugal and elsewhere meantime stepped up a gear this week and Q3 data out today confirmed the euro bloc back in recession.

Yet Europe is not the main driver of global markets at the moment. The latest MerrillBoA funds survey this week showed that, at 54%, more than twice as many funds now think falling off the US cliff and not the euro crisis is the biggest global investment risk. The euro group meets next week on Greece ahead of a two-day EU summit and we still have no clarity on Spain’s bailout either. There’s plenty of headline risk then, for sure, and the parallel release next week of November PMIs is hardly going to bring sweetness and light. That said, there’s been about as much good as bad news from Europe of late. The ECB is simply not going to pull the plug on Greece even if OSI gets pushed up to governmental level and take a lot more time. Spain and Italy have both now effectively completed funding for this year and there were very positive noises this week on Ireland returning to markets in early 2013 with a 10-year syndicated dollar bond, while Fitch raised its sovereign rating outlook to stable from negative.

So, generalised cliff gloom seems to have hit all risk markets indiscriminately. Over the past seven days, equities are lower, EM equities underperformed, Treasury and bund yields are down again (German 2-year back negative) and peripheral European yields have nudged back up again too. The dollar’s a little higher on the euro. On the other hand, oil and commods are up a bit – though that has as much to do with renewed MidEast tensions. What’s more, commodities in general are one of the few macro price gauges still in the red for 2012 — so to the extent that some of the global market pressures are related to year-end profit taking, then they may be in different territory.

All in all, this looks like a tired rather than overly anxious market. Implied equity vol remains relatively low and euro/dollar FX vol hit another five-year low this week.

Without detente in DC, maybe we’ll see continued chipping away of winning trades of the year so far. Developed market equity and emerging market equity and debt are all still up 10-20% YTD – so there’s plenty of room for that.

Yet, right or wrong, most big funds remain bullish into next year on at least a modest upturn in China and stabilisation in the United States but they also want the ‘cliff’ out of the way before committing new money.

Cliff aside, the US remains the favoured developed market, Turkey continues to be a darling in EM and the long-term underperforming China and BRIC plays may see some rebound if you believe that China is indeed troughing. The Chinese leadership change – for all the ‘Kremlinology’ – adds little new to the picture.

For the long-term bulls, there’s always the startling news from the IEA this week that the US will replace Saudi as the world’s top oil producer by 2017.

And for the emboldened bears, there’s always SocGen’s Albert Edwards. Uber-bear Edwards reckons the market is less worried about the fiscal cliff as it is about the corporate profits cliff it’s already spiralling off. “Expect the New Year to bring nothing but disappointment.” — Bah! Humbug!